The investment must be done in those opportunities where the NPV value is highest and in this situation spending money on project Alpha will result in highest NPV.
The four main investment appraisal technique methods are Payback Period (PP), Accounting Rate of Return (ARR), Net Present Value (NPV) and Internal Rate of Return (IRR). The four main investment appraisal methods used are segmented into two techniques. Non-discounted cash flow technique includes PP and ARR and discounted cash flow technique includes NPV and IRR.
Payback Period (PP) is the time acquired to equal the cash inflows and outflows. In the book ‘Financial Accounting for Decision Makers’ and ‘Accounting: An Introduction’ it is discussed that PBP method is important for future context and it is totally cash based. It is also mentioned that it ignores sunk cost and committed cost when applied (Atrill & McLaney, 2013).
Payback period is simple to calculate and useful in the short-term and consider the cash flows of the projects which makes it easier to evaluate the liquidity position of the company and decisions about the investment proposals. It explains the management about the time during which investment will be recovered and how quick it could be utilized for another project.
On the other hand, this method completely ignores the qualitative aspects of decision making. It is also not possible to analyze the useful life of the asset and does not consider how much cash flow will be generated after payback period is achieved. Payback period ignores the profitability of the company and decision taken on the basis of this method may cause the management to undertake a project which is not profitable.
ARR is also known as return on investment and is used to make an analysis of a project, which may take at least a year long time.